I HOLD THIS TRUTH TO BE SELF-EVIDENT, THAT A DEBT CRISIS CANNOT BE RESOLVED WITH MORE DEBT

Friday, September 23, 2011

Debt 4 More Debt Is 4 Fools

A full four years after the debt crisis raised its ugly head as a sub-prime loan snafu, it has morphed into a "sovereign debt crisis". And how could it not, since what intervened since then was basically a debt swap. The private sector could not borrow furiously any more, so the government(s) stepped in to take over as the Permagrowth/Permadebt locomotive.

In the United States the Federal Reserve printed money with gusto to buy Treasuries, and mortgage securities that no one else would touch.

M2 Money Stock Annual Rate of Change (%)

U.S. Treasuries Held by The Fed

Mortgage Securities Held by The Fed

In plain words, the only reason that the U.S. (and global) economy did not go into a full-fledged deflationary spiral was the printing press and Ben Bernanke's helicopter.

But, like all not-so-very-good things, this too must come to an end; and this time the locomotive is racing towards the end of the line and the hard brick wall known as "the sovereign debt crisis".

Three or four years ago I said that a mild deflationary approach, a small dosage of a bitter medicine judiciously administered would be better than revving up the monetary helicopter: just a touch of Andrew Mellon's "liquidate and purge" , instead of a gross misapplication of Keynes's governmental stimulus. It was counter-intuitive, yes, but along the time-tested lines of don't fight the previous war.

Obviously, it didn't happen, with governments (mostly the US and some of the EU) choosing to fight the private debt crisis with... even more debt of their own.

As this blog's masthead warned, the result was as predictable as mud after a rainstorm. The world now has no more appetite or capacity for even more dubious sovereign debt. There's no one left to borrow or lend in such huge amounts, necessary to keep the Permagrowth/Permadebt model going, and the locomotive itself is in clear danger of being swept under the mud.

4warned we were, alright, but we thought we could a4rd to 4get the hard lessons of history, so now we are becoming fodder 4 fools.4 shame...

Hell, you advocated mild deflationary approach and we are getting mild deflation since 2007 just as you prescribed. All this 'money printing' of Ben are directed toward avoiding a major deflationary collapse, and keeping the level of deflation small like you wanted.

Shouldn't you congratulate Ben for doing exactly what you asked for? Could it be that you do not know what you want?

A decent French blogger, Loïc Abadie - his writings are in local language, offers a view on the inflation/deflation debate that is quite simplistic. Simplistic but clear and IHMO relevant to the current crisis.

Starting early in the current crisis, in the early 2007, Loïc said:1- public debt is inflationary since can destroyed via monetization.2- private debts are per se deflationary,

Since globalization has been built up on a drastic increase of private debt, the chances that we avoid severe deflation are nil.

And conclusion arises mechanically with a return to a kind dollar and deflated markets all over the place.

Since English is only a difficult second language for me, I find it difficult to pay full tribute to the qualities of Loic's papers on the subject.

There is of course more than this in his robust thinking. However I'm coming to my point.

Sure In Europe the mechanics on public debt and seigniorage are clearly in distinct hands, including German ones for the later. In this case as in the case of sovereign emitted in strong foreign currency, public debt is deflationary.

However may I come to my point.

At this juncture, a significant part of the private debt has been transformed into public instruments. Either directly or indirectly.

This is certainly true for the US, the UK, Japan. The Euro-zone could be considered some kind of middle ground, at least now, since quite a number of German citizens, and their constitutional court, find it difficult to accept monetization.

(Privatization of the profits and) Socialization of the debts for sure have no deflationary consequences IMHO.

Those deflationary conditions à la nineteen century are not there any more.

You can certainly not force a donkey to drink or a citizen to purchase a home. But you certainly can monetize public budgets on an absolutely massive scale.

Is that debt? No, that's unfunded SPENDING. Is is inflationary? Yes and not mildly.

Can the robust and clear-thinking America drift into that for a while before recovering their mind? Yes, I bet it can.

Some have been here before. Of course possibly not in America.

For Mish and Loic to be proven wrong you of course need to guess what China, the great deflationary engines of the 90s and early 00s, will produce.

From this perspective, I certainly feel more in line with Chovanec views on China ("I suspect the pain will be just too great, and instead China will continue shadow-boxing with an inflation that it dare not take sufficient steps to curb. Expect its officials to turn a blind eye") than with Pettis ones.

By the way I am just waiting for the Fed to start shovelling its own cash into the system in the coming market crash.

I'd be certainly glad to be proven wrong and have no objection to getting the Bretton Woods stuff back on feet.

Betting on it, except for a temporary 3-to-6-months blip? No!

We used NOT to be in 1929 in 2007. We are no more in 1932 to-day.

Should a comparison be made, I'd compare more current US with central Europe 1873. With China in the role of the US, same period.

http://srnels.people.wm.edu/articles/realGrtDepr.html

By the way, one should not forget bankers and jews became scapegoats in Europe at that time and for a quite a number of years. Until the early 50s where the US view on money started to prevail again on the old continent.

I hope that Wall Street is getting reformed as soon as possible.

In view of what is at risk, the chances of a massive scapegoating are bigger by the day IMHO.

Bernanke et. al. are fighting a fundamental economic problem (the crumbling of the Permagrowth paradigm) with strictly monetary remedies. It's a bit like performing a rain dance to cure desertification, or building more stone statues in Easter Island to combat starvation from soil erosion.

All we end up with is more debt (more statues), and no change whatsoever where it really matters.

Instead, a REAL mild deflationary approach (i.e. deflate financial assets, including debt) coupled with a focus on the REAL economy is the approach I favor.

I still say, as I have since 2006/7 that we have no choice other than a mass pricipal reduction.

I also laid out the plans for it, but the people in power don't want solutions. They want to figure out a way to KEEP the current system (that got them their power) going.

Wouldn't you?

We suffer from evaporflation, which is compounding years of understated inflation. ...and that inflation, which is a paper created debt based asset, (rather than comodity/hard asset) expanded so far beyond control.... ...and so far beyond what money supply would have ever acknowledged, that it will continue to be understated for years to come as we try to pay off this unpayable debt.

On a personal note. 30 year reunion. No 4.0 GPA's for 110 years. 4 years to graduate. 30+110+4= 144 years. 2011 - 144years = 1867 Texas and Texus AM were both chartered right around then. Which did you go to?

Brian Woods... are you the same Brian Woods that went to SUNY Albany? (and worked at the Street)

>Were the ancient Greeks lazy? They fought wars among themselves all the time, so I don't think they had too much time on their hands. Particularly the Spartans..

Philosophers were mostly in Athens, the democratic part of Greece, isn't it?

BTW, I do not know whether you are aware that the father of greatest Greek cynic of classical era was a banker, who got caught for creating fake currencies. It is pleasing to know that cynicism is born out of banking industry :)

Browsing for sustainable stuff came across "FEASTA" on the web, liberal progressive (in the European sense) grouping of mainly Irish academics, economists / specialists on sustainable futures, alternative currencies, peak oil etc. Slight whiff of hippy on some topics, but I am a broad church.They have a collection of essays called "Fleeing Vesuvius" so their eschatalogical credentials are certainly up to the mark :) but generally all interesting stuff, equity partnership banking, renewable energy policy.

About Me

I was educated as a chemical engineer but spent almost my entire career in finance, particularly in money, FX and bond markets. The name stands for Hell-as-IOUs and the picture points to Quixotic endeavors.